(Bloomberg) -- The government’s proposal for a tax-free savings account for investing in UK companies could pump an additional £4 billion ($5 billion) a year into the stock market, helping to counter record outflows, according to an analysis by Peel Hunt Ltd.

The broker estimates that 1 million people would apply for the so-called UK ISA, a product proposed by Chancellor of the Exchequer Jeremy Hunt in March. Assuming they invest the full £5,000 allowed annually, a potential £40 billion could be channeled into UK stocks over 10 years after adjusting for portfolio reweightings, according to the report.

While this is very little compared with the $31.1 billion pulled from UK equity funds last year, according to EPFR Global data, Peel Hunt’s head of research Charles Hall says equity funds can drive the direction of the market, as well as being vital in supporting IPOs and equity capital raises. 

“The key driver of share prices over time is fund flows,” Hall wrote in the note published Thursday. “The annual allowance would enable investment in UK equities to grow materially over time.”

The proportion of domestic shares held by UK residents has been declining for years and was just 11% at the end of 2022. They are currently allowed to save or invest up to £20,000 per year in Individual Savings Accounts, or ISAs, without paying tax on interest or capital gains, but much of that money ends up in US tech stocks or global index funds. 

In November, a group representing money managers, brokers and companies argued for redirecting future ISA savings into British assets. Hunt’s UK ISA would be in addition to the current allowance. A consultation period on the proposal ends next month.

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According to Hall, 802,000 people used their maximum stocks and shares ISA allowances in the 2021/22 fiscal year. He expects most of those people to utilize the UK ISA.

Even so, he warned that the introduction of a product geared toward British investments may encourage some investors to reallocate more of their current ISA allowance toward foreign investments. This could be particularly the case among wealth managers, he added.

A major deterrent is that UK stocks have underperformed in recent years and a number of companies have been lured by other markets for share listings. Paris overtook London as Europe’s largest stock venue by market capitalization in 2022 and London is now the seventh-biggest globally, based on primary listings, trailing the US, China, Japan, Hong Kong and India.

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A £10,000 investment in the UK stock market a decade ago would now be worth £17,889 compared to £34,307 if the same sum had been placed in the MSCI’s developed market stocks index, according to Bloomberg calculations.

While Hall admits that the UK ISA “will not be a silver bullet,” he says it “can definitively be part of the solution.”

--With assistance from Henry Ren and Michael Msika.

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